Seek value when markets suffer from mass schizophrenia

November, 2008:- A Psychiatrist may well diagnose players in today’s turbulent financial markets around the world as suffering from a case of mass schizophrenia.

Just consider the violent price gyrations of stocks, bonds, currencies and commodities, the confusing and often contradictory expert observations and predictions, contracting confidence and scary headlines.In short, this dizzying behaviour fits the common and ordinary definition of schizophrenia – a mental disease in which the patient struggles to separate reality from unreal experiences and views the world as distorted and changeable without reliable landmarks.

By referring to this disease, I do not wish to demean the tragic circumstances of unfortunate people who either end up in mental institutions or suffer at home or on the streets.In fact, the analogy comes from a late bookmaker friend who described how some normal, straightforward individuals became entirely different personalities when they entered his betting shop. George Christidis, the bookmaker, was originally a dentist, a captain in World War II, a military historian and toastmaster. He ignored market gyrations and sought value. George didn’t try and time the market; instead, he spent time in the market, deposited his dividends and died a rich man.

Pounded with confusing news and and shot gun predictions

In today’s world of instant news on TV, the Internet, radio and print, the individual is bombarded with a surfeit of news that can hinder decisions.Long-time market veteran, Laszlo Birinyi of Birinyi Associates, the US money managers, longs for the days when decisions were made from one or two wire reports. The credit crunch, debt deflation, depreciating property and investment portfolios, and lower corporate and individual spending will inevitably lead to varying economic slowdowns or recessions around the globe.

The fearsome aspect of the current bear market is the depth and speed. It has fallen off a cliff similarly to 1987, but the big difference is the length–then a few weeks, now 13 months. The 1929 crash was also much swifter than this bear market–then came the lengthy BIG ONE. At the time there was monetary contraction and a tight Gold Standard vice, followed by fiscal expansion (New Deal). Now with extensive monetary and fiscal expansion, nations are battling a far far greater credit deflation and gigantic derivatives problem. That in essence is the weakness today, so that markets and recession cannot be compared to 1990’s, 1980’s and even 1970’s.

Beware of bottom picking in falling market, but begin to seek value

Be wary of bottom picking stocks that have fallen a long way. It is a matter of simple arithmetic. Say a stock slumps by 80 percent from 100 and you think, wow, at 20 it is a good buy. A few weeks later the press reports that the stock has fallen by 80 percent to 90 percent. The reader thinks that it isn’t serious. On the other hand if you bought the stock at 20 (80 percent from the top) and it falls to 10 (90 percent from the top), you are down by 50 percent.

There is thus a danger of buying too soon, just to observe the stock price sliding by 10 per cent to 20 per cent within weeks, if not days. Some of the biggest losses are incurred by bottom pickers in a bear market. Hedge fund risks have increased considerably as these players are being whipsawed. There are stars but they are few and far between. Last year’s hedge fund geniuses can be this year’s fools and as investors have been withdrawing money from them, they have tended to dump, good liquid stocks.

With the risks in mind, are stock markets now offering value?

There are signs that they are beginning to do so. Such have been the declines of sound company stocks that there appear to be plenty of opportunities. Wall Street will continue to lead the way. US 10-year treasury bonds are yielding less than 3 percent. Even though inflation is beginning to taper off as commodity prices fall, the real long bond yield is hardly positive. So bonds are only good value if disinflation turns into persistent deflation. In contrast, the current historic dividend yield of the Dow Jones index is 3.6 percent, and S&P 500 index, 3.5 percent. For comparative purposes, price-earnings ratios can be inverted into earnings yields, so the Dow Jones index is currently 9.4 percent and S&P 500, 9 per cent. Let’s take an extreme example.

Say, the bears are correct and profits slump by say 30 per cent, the Dow Jones earnings yield would fall to around 6.6 percent and the S&P 500 earnings yield, to 6.3 percent. Despite that decline, their earnings yields would still exceed Treasury bond yields.Let’s take some other markets as examples. Singapore’s dividend yield is currently around 4.3 per cent and earnings yield, 16.7 percent; Hong Kong, 3.1 per cent dividend yield and earnings yield, 10.3 per cent and Japan, 2.4 percent and 9 percent. The UK with a long bond yield of around 4.4 per cent has a dividend yield of 6.2 percent and earnings yield of 12.2 percent; and Germany, with a long bond yield of 4 percent, has a dividend yield of 4.3 per cent and earnings yield of 9.8 per cent, France 5 percent and 11.5 percent and Switzerland with a long bond yield of 2.8 percent, a dividend yield of 3 percent and earnings yield of 7.9 percent.

In volatile and nervous times, investors are reluctant to close their eyes and buy. But shrewd investors are watching and waiting, aiming to choose their stocks during such falls. The proviso is that the business is sound, has a low level of borrowings and a market with growth prospects when economies revive. We can’t all be George Christidises. But we can all learn to spot value in the market.

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Neil Behrmann

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